Comment 3 for bug 217348

In fact it is sufficient NOT to set root in menu.lst

What happens is that Wubi has an embedded menu.lst that looks for /ubuntu/disks/boot/grub/menu.lst and calls configfile. That already sets root to the disk and partition containing /ubuntu/disks/boot/grub/menu.lst. Since the disks will be in the same partition (/ubuntu/disks), setting root to /ubuntu/disks/boot/grub/menu.lst should not add much and if anything can point the bootloader to the wrong partition.

groot=(hdX,Y)/ubuntu/disks

should then be replaced

groot=()/ubuntu/disks

The latter sets only the relative path, but it does not change the root partition. This boot menu will only work when booted via wubildr (grub4dos), which should be acceptable since non-grub4dos bootloaders are not supported at this point and if the loopinstallation were to be migrated to a real partition, groot would have to be modified anyway.